Adding a 50/50 partner to Start up Business

[Mealianair]

Hello all,

About 5 months ago I set up an LLC in the state of Idaho. A friend (in Texas) decided to partner with my new business. We haven’t officially started yet and it’s a dotcom business.

My questions to you :

Where do I start as far as legal paperwork?

Could you list some necessary contracts that would be needed?

Thank you kindly.

Best,
Jason

[rdc]

Hi Jason,

Incorporation (and LLC formation) is one of the most important steps you can take towards launching your new business. Unfortunately, a lot of folks make the mistake of skimping on this very fundamental step by doing it themselves, using a one-size-fits-all option like Legalzoom, or worse, paying a non-attorney to advise upon and do this for them.

Here are a few thoughts that will hopefully be helpful.

1) You might want to get into the habit of referring to other individuals/owners of the LLC as "members" (or "managers", in some cases--see below) rather than "partners". It's more accurate, and when you get into agreements/contracts dealing with the LLC (whether internal, organizational documents, or external--with outside parties), you can ensure that documents/words have the proper legal effect.

2) You will want to make sure that the proper filings have been done. In addition to filings with the secretary of state, there will be other documents to file. In particular, you want to ensure that a federal EIN has been obtained before adding a second member/manager. Depending upon the situation, there may also be filings required with the department of labor and the like.

3) Depending on the dynamic you are going for, your LLC may be set up as a "manager-managed", or "member-managed" LLC. There is a very major difference here. If you don't know which way you've set it up... you might want to find out, and ameliorate any issues in this regard, if need be. Then decide which structure best suits the situation you and your new business partner desire. The new business partner may be an member, a manager, or both. And "manager" in this sense is not necessary synonymous with the popular connotation of a business "manager"; keep that in mind. The way that this is structured will also have some fundamental effect(s) on tax, as well.

4) On that note, while technically an SMLLC (single-member LLC) can exist and operate without an LLC operating agreement (or perhaps a form one downloaded off the internet or sites like Legalzoom), when you bring in a second person (or more), you really MUST contact an attorney about consulting upon, and developing, an appropriate LLC operating agreement. This is the core contract that "builds" your LLC, determines how it will function, and provides recourse in the event that things go wrong in the future (and I would recommend not being naive in this area--business partnership relationships are very tricky, even for seasoned businesspeople and entrepreneurs). Again, tax planning is implicated here--refer to Internal Revenue Code sections dealing with partnership tax (and LLC tax).

5) Certain provisions MUST be made within the LLC Articles of Organization, and putting them in the Operating Agreement is insufficient. This is a common area of error (moreso in corporations, but still), even for attorneys who don't specialize in this area, sometimes. Stock classes are one.

6) Depending upon your goals, you may also need employment/key employee contracts in place. If you've already built some value within the business, this may be advisable before bringing someone else in.

7) I already mentioned tax, but to reiterate; if there is already value built in the business, structuring things one way can mean very different tax effects (e.g., taxes owed this year by the new member) can have very different tax effects than doing it another way. An attorney experienced in this area can advise upon the structure that will produce the optimal outcome in this regard.

8) If you want to utilize equity as a sweetener for other parties, such as employees and/or service providers, you may need to set up a mechanism for this, e.g. an incentive stock plan or phantom stock plan.

9) If you plan to raise money (sell equity in the company, or anything else), be sure to comply with federal and state securities laws... This is paramount. You probably aren't doing this at this stage, but since it's dotcom, you very well could find yourself in this situation. Best to have an attorney versed in this area before going into any transactions of this sort.

If I can help you with any of this, please let me know.

[akula]

some awesome advice from rdc
Richard, i am grateful that you've been able to provide such detailed, relevant and helpful feedback for our members.
thank you!

[rdc]

Thanks Akula; you're very welcome. Glad to be of help :]

[akula]

Hello all,

About 5 months ago I set up an LLC in the state of Idaho. A friend (in Texas) decided to partner with my new business. We haven’t officially started yet and it’s a dotcom business.

My questions to you :

Where do I start as far as legal paperwork?

Could you list some necessary contracts that would be needed?

Thank you kindly.

Best,
Jason

hmmm...yes...incorporation and tax stuff aside, the other bit of paperwork that you might need (although technically it's not mandatory, but highly desirable) is the one that explains why there is a 50/50 split in llc member interest in the first place....this is an important document if you want to run a business that encourages performance, plus there are other reasons.

for example; a year after launch, your friend might resign from his job in the company, or start working part time, whilst you remain working full time on the biz. this will then beg the question, why is he getting the same ownership share (i.e. claim on profits) as me if i'm working more than he is? alternatively, if the biz takes off, you might take on another member who will want to know how much each of you guys invested to get your 50% interest in the llc, or, in the future you'll might want to buy out your partner's interest in the biz, or offer to sell him your share. to avoid arguments about price in these circumstances, certain documents are of use.

this paperwork comes usually in the form of an employment/contractor agreement between you and the llc..which basically says something like "my name is jason and i'm promising to do $x amount of work for the company, in return for which i get %y member interest in the company, because each 1% interest is worth $z"...this way, the membership interest will fluctuate to reward people who contribute more to the business. likewise, it provides a record of explaining why someone has a certain percentage member interest in the llc, if the issue comes up in litigation or company sale etc..

yeah..so, in order to have a fair company that rewards and encourages effort, what you might want to do is start of with a 50/50 split in ownership units, but then have the llc issue more ownership units as a pseudo form of salary or reward for individual achievement in meeting certain performance milestones. overtime, this will dilute other members and present a true picture of each individual's commitment to the biz

[lawinc]

Obviously, having a 50-50 split has the potential to create some arguments when a corporate decision has to be made. With a majority shareholder (and only a majority required in the partnership agreement) all corporate decisions are made by that shareholder. One benefit I could possibly see to a minority shareholder is where the partnership decided to do something unethical and was sued, the minority shareholder may be able to claim that you didn't want the partnership to move in that direction and you may be able to have your name removed from the lawsuit. However, I am not a lawyer, and that is just pure speculation from a business point of view.